Everyone’s situation is different. But here are a few things to consider that can help you make the decision that’s right for you.
Start with your budget.
It's not easy to juggle basic expenses like rent, utilities, transportation, and groceries. If you are paying for these with ease — and have money left over — congrats! The next step is deciding how to spend your extra cash.
Small splurges are healthy, but too many could hinder your financial goals. If you are itching to pay off debt, invest, or both, budgeting is essential. Take the time to track exactly how much money is coming in vs. going out.
Save an emergency fund.
Before funneling cash into debt or investments, you need at least a small emergency fund. This is your stash for costly, unexpected expenses– car repairs, medical bills, and job loss are all part of life.
By seting money aside — even $1,000 or $2,000 to start — it's less likely these curveballs will increase your debt. If you have high-interest debt, you may consider a slightly lower number — at least until your most expensive debt is gone. Aim for a long-term goal of three to six months of expenses.
Don't skip your company's retirement plan matches.
Before diving into a new debt payoff or investing strategy, review your company's retirement plan. Many companies offer to match a percentage of your 401(k) or 403(b) contributions. That’s free money for you.
Skipping this perk is like giving up part of your salary so you want to be sure to lock this in while you focus on your other goals.
Pay off high-interest debt before investing.
If you are paying off debt, you’re not alone. Most Americans have it — including mortgages, student loans, credit cards, car notes, and more. But not all debt is equal.
There's a big difference between your 5.05% federal student loan and 16.99% to 23.91% credit card debt. High-interest credit card debt costs more over time making it much more difficult to pay off. By tackling it first, you could save hundreds or even thousands of dollars in interest. Best of all, it may free up cash to add to your emergency fund or kickstart your investing plan.
Why investing matters.
Before diving into the specifics, it's helpful to understand the basics of investing. While investing for the long-term involves increased growth potential, it also comes with increased risk. When you invest in equities (stocks) for example, your money can grow through dividends to shareholders or if the equities you are holding increase in price.
Unfortunately, younger people are less likely to invest than their parents. According to a recent Gallup poll, only 37% of people under 35 currently invest in the stock market — down from 52% before the 2008 crash. It's normal to fear the stock market. Afer all, no one can predict what the future will look like. But, skipping out on investing early in your career means missing out on years of building wealth.
When to invest before paying off debt.
To choose between paying off debt vs. investing, you have to review the numbers. You should compare your expected investing return vs. how much interest you are paying. Ofen, you need to consider taxes too.
Some types of interest — like student loans or your mortgage — may offer a tax incentive, depending on your income. These are more confusing, so be sure to ask a tax professional for guidance. If you decide to invest vs. pay off debt sooner, you’ll still have to make on-time minimum monthly payments. Otherwise, you could hurt your credit score and end up having to pay higher interest rates for years to come.
Pay off debt or invest? Your feelings matter, too.
If you're a numbers person, it's easy to see the power of investing. Small, regular contributions may grow more than you expect. By crunching the numbers, it's easy to see whether paying off debt or investing is the smarter choice. Paying off low-interest debt sooner may not be best — especially if you expect to earn more elsewhere.
But math doesn't factor in your feelings or personal risk tolerance. Debt ofen causes a lot of stress. If the weight keeps you awake at night, there is nothing wrong with paying it down sooner. You can’t put a price tag on your peace of mind. The decision is yours.
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